Porter's 5 Forces

This is a business model for assessing the competitive forces that shape the future of a company.

Michael Porter published an article in the Harvard Business Review in 1979 entitled How Competitive Forces Shape Strategy. There has been the inevitable analysis and criticism of the model since then but its wide use and appeal is testimony to the significant contribution it has made to strategic thinking. In particular, the five forces are those that influence the profit structure of an industry as they determine how the economic value is apportioned. It can be drained away by any of the forces – rivalry between competitors, the power of suppliers, the power of customers, new entrants and substitutes.

The five forces (rivalry, power of suppliers, power of customers, new entrants, substitutes) are not macro factors such as those described in the PEST model (political, economic, social and technological), rather they are micro-factors much closer to a business. The forces are likely to have an immediate effect on the company and influence its ability to serve its customers and make a profit.

​Industry rivalry

The central force, the one that is usually in the face of every business, is the rivalry that exists with other competitors in the market. Markets can be highly aggressive with all the suppliers attacking each other on price, quality, and delivery. Sometimes in mature markets there are a limited number of suppliers (an oligopoly) and the rivalry resembles an orchestrated dance. This is not necessarily collusion (this would be classed in most countries as illegal), rather they are actions that are taken through years of learning the best moves to make following a change made by another supplier.

Bargaining power of suppliers

Suppliers can have a huge influence on competitiveness.  For example, there is only one major source of cobalt in the world and this is in the Democratic Republic of Congo. Cobalt has become a vital material in the manufacture of batteries for electric cars. As car manufacturers ramp up their electric car production lines, speculators have amassed large stockpiles of cobalt driving up its price[i]. Companies such as Tesla that require batteries for its electric vehicles are being forced to pay the premiums caused by restricted supply. It isn’t just raw materials that can influence a company’s competitive position. A supplier of power tools could disenfranchise one of its dealers removing a major product line from the distributor’s portfolio and putting its business under threat.

Threat of substitutes

A company’s competitive position can be weakened by substitutes. Almost all products have some form of substitution. If coffee becomes too expensive, people can turn to tea, hot chocolate or other beverages. If rail fares become too expensive people can consider travelling by road or air. Metal can be replaced by plastic; coal can be replaced by oil or gas. Substitution isn’t always easy. People get hooked on coffee and will not readily change. Advanced composites offer significant advantages in the manufacture of the airframes and interiors of new jetliners but they can only be built into new models as the designs of existing aircraft are approved and cannot easily be changed.

Threat of new entrants

The cosy position enjoyed by suppliers to a market can be disrupted by new players. Any new supplier will steal some share. They could have a lower price, a superior product or a completely different way of serving the market. In some cases the cost of entry is low. A Chinese manufacturer of steel can sell its products into Europe relatively easily. It already has a manufacturing base in China and all it has to do is to transport the material and pay the import duties. In other markets it may be more difficult. It would be difficult for a new company to enter the electric car market as the cost of manufacturing electric cars is extremely high. The investment in manufacturing facilities and marketing will limit entry to rich billionaires who are brave and committed enough to break the traditional mould.

Bargaining power of buyers

In some markets there are a limited number of large buyers who can dictate prices and terms. Dairy farmers supplying supermarkets and grocery stores find themselves dictated to by their large customers. Service companies wanting to do business with large corporate companies are seldom in a position to strike a hard bargain as buyers have a wide choice of often quite desperate suppliers. Many small and medium enterprises find themselves in a position where they are dependent on one or two customers for the bulk of their revenue. These companies are highly vulnerable to the loss of one of these large customers and are likely to yield to pressure from them simply to keep the business.

Porter referred to the threat of substitutes, the threat of established rivals and the threat of new entrants as “horizontal” competition. The bargaining power of suppliers and the bargaining power of customers he considered to be “vertical” competition.

The Five Forces model will not, on its own, point to a strategy. The model will show the weight of influence of each micro-force that surrounds the company. It may be helpful to also carry out a PEST analysis and understand the higher level forces before examining the five forces.  Armed with this understanding of what is shaping the business, a SWOT would complete the strategic overhaul.

Some things to think about:

• Competition is a threat but it can usually be managed. Use the 5 forces to work out where the main threat comes from so that it can be minimised.

  
  

• Consider also carrying out a PEST analysis which will take account of the macro factors shaping your business.